Strategic Cost Management

Quiz 3: Lifecycle Costing, Decentralization and Variable Costing

1. A - Target Costing
2. B - Maturity
3. B - Capitalized and allocated over the life cycle
4. B - The target cost
5. D - 90%
6. B - no, yes
7. C - P38
8. C - Selling price – profit margin = target cost

9. Required:

1. Assuming the use of variable costing, compute the cost of Sosyal's ending finished-
goods inventory.
Variable production costs total: (P300,000 + P420,000 + P360,000) = P1,080,000
1,080,000 ÷ 60,000 units = P18 per unit
[0 + 60,000 – (60,000 x 90%)] = 6,000 units remain in inventory
Ending finished goods inventory: (6,000 x P18) = P108,000

2. Compute the company's contribution margin. Would Sosyal disclose the contribution
margin on a variable-costing income statement or an absorption-costing income
statement?

Sales revenue (60,000 units x 90% x P55) P2,970,000

Less: Variable cost of goods sold
(60,000 units x 90% x P18) P972,000
Variable selling and administrative 120,000 1,092,000

Contribution margin: P1,878,000

- Sosyal disclosed the contribution margin on a variable-costing income statement.

3. Assuming the use of absorption costing, how much fixed selling and administrative
cost would Sosyal include in the ending finished-goods inventory? 
- None, because all fixed selling and administrative cost is treated as a period cost and
expensed against the revenue.
 4. Compute the company's gross margin.

The addition of fixed manufacturing overhead increased the cost of a unit by P10
(600,000 ÷ 60,000 units) = P10 per unit

Therefore:

Sales revenue P2,970,000

Cost of goods sold (60,000 units x 90% x P28) 1,512,000

Gross margin: P1,458,000

10. Required:

1. What is the cost of Venture's end-of-period finished-goods inventory under the

variable-costing method?

Ending finished-goods inventory (units): 0 + 100,000 – 90,000 = 10,000

Inventoriable costs under variable costing:

Direct materials used P400,000

Direct labor 200,000
Variable manufacturing overhead 120,000

Total: P720,000
Variable cost per unit produced: P720,000 ÷ 100,000 units = P7.20 per unit
Ending Inventory: 10,000 units x P7.20 = P72,000

2. Calculate the company's variable-costing net income. 

Sales revenue (90,000 units x P15) P1,350,000

Less: Variable costs [(90,000 units x P7.20) + P45,000] 693,000
Contribution margin P657,000
Less: Fixed costs (P250,000 + P300,000) 550,000

Variable-costing net income: P107,000

3.  Calculate the company's absorption-costing net income. 

Predetermined fixed overhead rate: P250,000 ÷ 100,000 units = P2.50

Absorption cost per unit: P7.20 + P2.50 = P9.70

Sales revenue (90,000 units x P15) P1,350,000

Less: Cost of goods sold (90,000 units x P9.70) 873,000
 Gross margin P477,000
Less: Operating costs (P300,000 + P45,000) 345,000

Absorption-costing net income: P132,000

11. Required
1. By how much would the company’s net operating income increase if Cebu increased it
sales by Php75,000 per year? Assume no change in cost behavior patterns. 

The company’s net operating income would increase in P30,000. Because, P75,000 x 40% CM
ration = P30,000 increased contribution margin in Cebu. Considering, that there will be no
change in fixed costs in the office as well as in the company as a whole, the entire P30,000
would result in increased net operating income for the company. It is also incorrect to multiply
the P75,000 increase in sales by Cebu’s 25% segment margin ratio, this approach assumes
that the segment’s traceable fixed expenses increase in proportion to sales but doing this
approach, it would not be fixed.

2. Refer to the original data. Assume that sales in Manila increase by Php50,000 next
year and that sales in Cebu remained unchanged. Assume no change in fixed costs. 

a. Prepare a new segmented income statement for the company using the format
above. Show both amounts and percentages. 

New Segmented Income Statement:

Segments

Total Company Manila Cebu

Amount % Amount % Amount %

Sales P800,000 100.0% P200,000 100% P600,000 100%

Less variable expenses 420,000 52.5 60,000 30 360,000 60
Contribution margin 380,000 47.5 140,000 70 240,000 40
Less traceable fixed expenses
168,000 21.0 78,000 39 90,000 15
Office segment margin 212,000 26.5 P62,000 31% P150,000 25%
Less common fixed expenses not
traceable to segments
120,000 15.0
Net operating income P92,000 11.5%
 b. Observe from the income statement you have prepared that the CM ratio for
Manila has remained unchanged at 70% (the same as in the data above) but that
the segment ratio has changed. How do you explain the change in the segment
margin ratio?

- The segment margin ratio changes, it rises and falls as the sales rise and fall because of the
presence of fixed costs. The fixed expenses are spread over a larger base as the sales
increase. Contrary to the segment ratio, the contribution margin ratio is a consistent figure for
so long as there is no change on both the variable expenses and the selling price of a unit of
service.